Method of recording and paying declared dividends in an investment company that invests in fixed income securities and has conventional and ETF share classes with different dividend payment frequencies

ABSTRACT

A method is are provided to administer an investment company. The investment company issues one or more classes of shares that are bought from and redeemed with the investment company at a net asset value. The investment company also issues one or more classes of shares that are listed for trading on a securities exchange and that are bought and sold in a secondary market at negotiated market prices. One or more computers maintain information regarding portfolio holdings of the investment company and outstanding shares in the investment company. Dividends are periodically declared at a first time interval for the outstanding shares that are bought from and redeemed with the investment company at a net asset value. The amount of dividends to declare is calculated from the information maintained in the one or more computers. Dividends are periodically declared at a second time interval that is different from the first time interval for the outstanding shares that are exchange-traded. Again, the amount of dividends to declare is calculated from the information maintained in the one or more computers.

CROSS-REFERENCE TO RELATED APPLICATIONS

This application is a continuation of copending U.S. application Ser. No. 11/858,668 filed Sep. 20, 2007, which is incorporated by reference herein in its entirety.

This application relates to U.S. Application No. 60/973,991 filed Sep. 20, 2007, converted to U.S. application Ser. No. 11/955,854 filed Dec. 13, 2007, now U.S. Pat. No. 7,461,027 entitled “Basket creation process for actively managed ETF that does not reveal all of the underlying fund securities”.

COPYRIGHT NOTICE AND AUTHORIZATION

Portions of the documentation in this patent document contain material that is subject to copyright protection. The copyright owner has no objection to the facsimile reproduction by anyone of the patent document or the patent disclosure as it appears in the Patent and Trademark Office file or records, but otherwise reserves all copyright rights whatsoever.

BACKGROUND OF THE INVENTION

U.S. Pat. No. 6,879,964 (Sauter et al.), hereafter, “the '964 patent,” which is incorporated herein by reference, discloses a single investment company that issues one or more classes of shares that are bought from and redeemed with the single investment company at a net asset value (conventional shares) and also issues one or more classes of shares that are listed for trading on a securities exchange and that are bought and sold at negotiated market prices (exchange-traded shares). The invention described in the '964 patent has been commercialized by selected fund companies of The Vanguard Group, Inc. which now offers exchange-traded shares (referred to as “VIPER shares” in the '964 patent) as a separate share class in a plurality of its previously existing equity funds.

It would be desirable to provide a similar class of exchange-traded shares for investment companies that invest some or all of their assets in fixed income securities. However, there are many complexities to extending the invention of the '964 patent to these types of investment companies. The present invention addresses such complexities so that these types of investment companies can also provide a class of exchange-traded shares.

BRIEF DESCRIPTION OF THE DRAWINGS

The foregoing summary as well as the following detailed description of preferred embodiments of the invention, will be better understood when read in conjunction with the appended drawings. For the purpose of illustrating the invention, the drawings show presently preferred embodiments. However, the invention is not limited to the precise arrangements and instrumentalities shown. In the drawings:

FIG. 1 shows a schematic block diagram of one preferred embodiment of the present invention.

FIG. 2 shows a flowchart of an active bond ETF basket creation process in accordance with one preferred embodiment of the present invention.

FIG. 3 shows a flowchart of a dividend distribution process in accordance with one preferred embodiment of the present invention.

BRIEF SUMMARY OF THE INVENTION

One preferred embodiment of the present invention provides methods and apparatus that administer an investment company. The process operates as follows:

1. The investment company issues one or more classes of shares that are bought from and redeemed with the investment company at a net asset value.

2. The investment company also issues one or more classes of shares that are listed for trading on a securities exchange and that are bought and sold in a secondary market at negotiated market prices.

3. One or more computers maintain information regarding portfolio holdings of the investment company and outstanding shares in the investment company.

4. Dividends are periodically declared at a first time interval for the outstanding shares that are bought from and redeemed with the investment company at a net asset value. The amount of dividends to declare is calculated from the information maintained in the one or more computers. 5. Dividends are periodically declared at a second time interval that is different from the first time interval for the outstanding shares that are exchange-traded. Again, the amount of dividends to declare is calculated from the information maintained in the one or more computers.

Another preferred embodiment of the present invention provides methods and apparatus that administer an actively managed investment company that invests assets in fixed income securities. The process operates as follows:

1. The investment company issues one or more classes of shares that are listed for trading on a securities exchange and that are bought and sold in a secondary market at negotiated market prices.

2. The investment company selects and holds a portfolio of fixed income securities that relate to a benchmark index. The selection is made in an actively managed manner such that the duration range of the securities holdings is either longer than the duration of the benchmark index (also referred to herein as being “bullish”), close to the duration of the benchmark index (also referred to herein as being “neutral”), or shorter than the duration of the benchmark index (also referred to herein as being “bearish”). 3. The investment company defines a creation unit basket that has a duration that is equal to a midpoint of the duration range of the securities holdings of the investment company. 4. The investment company periodically publishes the creation unit basket to facilitate creation and redemption of the exchange-traded shares.

DETAILED DESCRIPTION OF THE INVENTION

Certain terminology is used herein for convenience only and is not to be taken as a limitation on the present invention. In the drawings, the same reference letters are employed for designating the same elements throughout the several figures.

Shares that are bought from and redeemed with the investment company at a net asset value are referred to interchangeably as “conventional shares.” Shares that are listed for trading on a securities exchange and that are bought and sold in a secondary market at negotiated market prices are referred to interchangeably as “exchange-traded shares” or “ETF shares.”

I. Overview of System

FIG. 1 shows a schematic block diagram of a system 10 in accordance with one preferred embodiment of the present invention. The system 10 is similar to the system shown in FIG. 1 of the '964 patent, except that the “VIPER shares” referred to in the '964 patent are now referred to as “ETF shares,” and there are additional elements provided to facilitate the present inventive features.

Referring to FIG. 1 of the present specification, the system 10 includes an investment company 12 (also, referred to interchangeably as “the Fund”), investors A, B and C (labeled as 14, 16 and 18, respectively), an authorized participant (also known as a “market maker” or “specialist”) 19, brokers 20 and a clearinghouse 22. The investment company 12 includes a first processor 24 that records one or more classes of conventional shares issued by the investment company 12, a second processor 26 that records one or more classes of ETF shares issued by the investment company 12, a database 50 that stores information about the investment company's portfolio holdings (i.e., the pool of underlying securities), and a database 52 that stores information about dividend declarations for the multiple share classes (e.g., payment dates, ex-dividend dates, amounts of dividends paid). In the presently described embodiment, the first processor 24 records one class of conventional shares issued by the investment company 12, such as a class of conventional shares that has a relatively small minimum investment of $1,000 or $3,000 (“investor shares”). Alternatively, the class of conventional shares could have a relatively large minimum investment, such as $10 million (“institutional shares”). In the presently described embodiment, the second processor 26 records one class of ETF shares issued by the investment company 12. However, the scope of the present invention includes embodiments wherein plural classes of ETF shares are issued. The investment company 12 also includes a database 28 for maintaining shareholder account data. For each shareholder of the investment company 12, the database 28 maintains a record of the amount of conventional shares. The database 28 also maintains a single account that tracks all of the outstanding ETF shares. The investment company 12 further includes a portfolio trading and management computer 54, a portfolio manager 56, and a database 58 that contains the current basket of securities used for creating and redeeming ETF shares.

Investor A represents one or more investors who have purchased conventional investor shares in exchange for cash. Investor B represents one or more investors who have purchased conventional institutional shares.

Investors who wish to purchase ETF shares in quantities smaller than a Creation Unit must purchase the shares on the secondary market through a broker. This process is represented by the investors C (labeled as 18), the brokers 20, the authorized participant 19, and the clearinghouse 22.

An authorized participant 19 is a financial entity that maintains firm bid and offer prices in a given security by standing ready to buy or sell round lots at publicly quoted prices. On an exchange, an authorized participant is the member firm that makes a market in the stock and maintains the limit order book. In the present invention, the authorized participant 19 purchases ETF shares in Creation Units from the investment company 12 which are settled through the clearinghouse 22. The authorized participant 19 has a computer 37 for tracking its account data. In the current financial industry, the clearinghouse 22 is the Depository Trust Company (DTC). The DTC is a national clearinghouse for the settlement of trades in corporate and municipal securities and performs securities custody-related services for its participating banks and broker-dealers. DTC is owned by members of the financial industry and by their representatives who are its users. The use of other clearinghouses is within the scope of the present invention.

If an investor C wants to purchase ETF shares, the investor C places an order with its broker 20. The broker 20 then purchases the ETF shares from the authorized participant 19 for the investor C. In this example, the brokers 20 are labeled as broker 34 (broker 1) and broker 36 (broker n). Each broker 34, 36 has a computer for tracking brokerage account data for its shareholders, labeled as elements 38 and 40, respectively. Each broker 34, 36 may have many investors. In this example, investor 42 (investor C1 ₁) and investor 44 (investor C1 _(n)) have accounts with broker 34, and investor 46 (investor Cn₁) and investor 48 (investor Cn_(n)) have accounts with broker 36.

The clearinghouse 22 has a record of all outstanding ETF shares issued by the investment company 12.

FIG. 1 shows only purchase transactions. Sell-type ETF transactions are performed by a reverse of the ETF purchase transactions.

The investment company could be an open-end fund (e.g., open-end mutual fund), a closed-end fund (e.g., closed-end mutual fund), or a UIT. The ETF shares issued by the investment company are publicly listed and traded on a national stock exchange, such as the American Stock Exchange (AMEX). The investment company could have an investment objective of tracking a specific target index of securities (i.e., an index fund). Alternatively, the investment company could be actively managed by an investment advisor in a manner that does not attempt to tightly track a target index.

In one preferred embodiment of the present invention, ETF shares may be acquired in one of two different ways:

(1) An investor may purchase ETF shares directly from the investment company 12 in exchange for a basket of securities of generally equivalent monetary value. Preferably, the direct purchase requires a purchase of a predetermined number of ETF shares, known as a “Creation Unit.” The account data is then updated to include the newly purchased shares. A “Creation Unit” will preferably cost millions of dollars, and thus, Creation Units will be purchased primarily by institutional investors who have been pre-approved.

(2) An investor may purchase ETF shares on the secondary market through a broker. The account data of the investor, as maintained by the investor's broker, is then updated to reflect the new number of shares held by the investor.

In one preferred embodiment of the present invention, ETF shares may be sold or redeemed in one of two different ways:

(1) An investor may redeem ETF shares directly with the mutual fund in exchange for a basket of securities of generally equivalent monetary value. Preferably, only Creation Units may be redeemed in this manner.

(2) A shareholder may sell ETF shares directly on the secondary market through a broker.

II. Active Bond ETF Basket Creation Process

FIG. 2 is a flowchart of an active bond ETF basket creation process. This process may be used in an investment company that invests most, substantially all, or all of its assets in fixed income securities, such as bonds. In one exemplary embodiment, the process in FIG. 2 operates as follows:

1. The portfolio manager (PM) 56 of the investment company 12 determines that there will be duration ranges for the Fund.

2. The PM determines what the boundaries of the duration ranges will be, vis-á-vis the duration of the Fund's benchmark or target index (e.g., the Bear range is −0.75 yrs to −0.375 yrs, the Neutral range is −0.375 yrs to +0.375 yrs, the Bull range is +0.375 yrs to +0.75 yrs). 3. The PM determines, based on experience, research and market conditions, which duration range the Fund should be in (considering future interest rate expectations). 4. The PM buys/sells underlying securities so that the Fund's duration range matches the PM's determination of which duration range the Fund should be in. 5. The PM calculates the midpoint of the Fund's current duration range. 6. The PM selects the securities that will be included in the Basket and the extent of overlap between Basket securities and the Fund's actual underlying securities (e.g., target 50-75% for a Treasury inflation-protected securities (TIPS) fund, 40-50% for a non-TIPS Treasury bond fund). 7. The PM establishes the respective weightings of the Basket securities, so that the duration of the Basket always matches the midpoint of the Fund's current duration range. —For example, regardless of whether the PM is currently taking a moderately Bullish, medium Bullish, or strongly Bullish position, the duration of the Basket will always match the midpoint of the Bullish range. Likewise, regardless of whether the PM is currently taking a moderately Bearish, medium Bearish, or strongly Bearish position, the duration of the Basket will always match the midpoint of the Bearish range. Likewise, regardless of whether the PM is currently taking a Neutral leaning towards Bullish, medium Neutral, or Neutral leaning towards Bearish position, the duration of the Basket will always match the midpoint of the Neutral range. 8. The contents and weightings of the Basket securities are made available to third parties (including Authorized Participants (APs) and Specialists) to facilitate Creation Units. 9. When those third parties provide the Basket securities to the Fund, the Fund issues Creation Units/ETF shares. As discussed in FIG. 1, the reverse process happens during the redemption process.

In one preferred embodiment, the Fund's Creation Basket is published once each business day via any suitable electronic or print media. Although the Creation Basket is expected to sufficiently closely track each applicable Fund, each Fund's Adviser preferably will not disclose intra-day changes in the Fund's investment portfolio to Authorized Participants or change the Deposit Securities during the day to reflect changes in the Fund's investment portfolio.

The composition of the Creation Basket must very closely resemble the composition of the investment portfolio of each Fund in order that (i) the market value of the Creation Basket will closely track the same-day NAV of that Fund's ETF shares, and (ii) specialists and market makers will have sufficient information about that Fund to maintain reasonable spreads between the bid and offer prices of ETF shares. Because each Fund is actively managed, however, the Fund has a fiduciary responsibility to keep confidential the exact composition of the Funds and changes to the composition of the Funds so as to prevent front running and free riding. This duty of confidentiality prevents the production of a Creation Basket that exactly mirrors the full portfolio holdings of the Funds. That is, the Creation Basket should not reveal all of the Fund holdings. The Creation Basket described herein accomplishes this goal.

The desired level of tracking between the market value of the Creation Basket and the same-day NAV of the Funds is achieved by selecting the weightings of the securities in the Creation Basket according to two requirements. The first Creation Basket requirement specifies that the Creation Basket must be a representative sample of the securities comprising the investment portfolio of each Fund. This requirement ensures substantial identity between the Deposit Securities and the securities comprising the investment portfolio of the Funds, which will increase the degree of positive correlation of price movements between the Creation Basket and the Funds' ETF shares.

The second Creation Basket requirement specifies that the Duration and Yield Curve Slope Exposure of each Fund's Creation Basket must closely approximate the Duration and Yield Curve Slope Exposure of the investment portfolio of the corresponding Fund. In the case of Duration, each Fund's Adviser assigns a rating of Bullish, Neutral or Bearish to the interest rate sensitivity of the Fund's investment portfolio. For each of these options, a specific number is defined to be the midpoint of a range represented by that rating. Then, the weightings of the securities in the Creation Basket are selected such that the Duration of the Creation Basket is calculated to be approximately the same as the midpoint of the Duration range which is assigned to the Fund's investment portfolio. This process is also summarized in FIG. 2, described above.

Each Fund's Adviser also structures the securities which comprise the Creation Basket so that the Yield Curve Slope Exposure of the Creation Basket closely approximates the Yield Curve Slope Exposure of the corresponding Fund's investment portfolio. These controls ensure that the Creation Basket and the investment portfolio of the applicable Fund will have similar exposures to the principal market forces that drive the performance of a portfolio of U.S. Government and Agency Securities, which will further increase the degree of positive correlation of price movements between each Fund's Creation Basket and ETF shares. In a further alternative embodiment, the Creation Basket further has a breakeven inflation (BEI) exposure that is approximately matched to the BEI exposure of the securities holdings.

The use of these two Creation Basket requirements will usually allow the Fund to keep the composition of the Creation Basket unchanged even when the composition of a Fund's investment portfolio changes modestly. For example, if a Fund were to add a new security, the corresponding Creation Basket would not have to make any change unless the change to the Fund was of such a magnitude that either (i) the Creation Basket would no longer be a representative sample of the Fund, or (ii) the overall duration of the Fund changed to a new range.

The creation basket process may be implemented in an investment company that offers ETF shares as the only class of shares, or offers ETF shares as a class of shares in addition to one or more classes of conventional shares. If the creation basket process is implemented in an investment company that offers ETF shares as the only class of shares, the system of FIG. 1 would not include the processor 24 that issues the conventional shares, the shareholder account data in the database 28 (since there would be no individual shareholder accounts to track), or the investors 14 and 16 who purchase and redeem conventional shares.

Additional details of the active ETF basket creation process are described in Appendices A and B.

III. Dividend Distribution Process

In most conventional fixed income funds, dividends are declared daily and paid monthly. As described in Appendix B, there are many reasons why it would not be practical for funds to declare dividends daily for an exchange-traded class of shares and why the dividend payment dates cannot be the same for conventional shares and exchange-traded shares. In one embodiment of the present invention, dividends are declared daily and paid monthly for conventional shares, but dividends are declared only monthly for the ETF share class(es) and paid several days later than the payment date for the conventional shares.

FIG. 3 shows a flowchart of a dividend distribution process in accordance with one preferred embodiment of the present invention. In this example, there are two classes of shares, one conventional share class, such as the investor shares shown in FIG. 1, and one ETF share class. The income earned on the portfolio is allocated daily among the share classes based on their relative net assets.

Although conventional shares and ETF shares both will pay dividends monthly, the payment date for the ETF shares will be a few days later than for the conventional shares. The delay in payment of dividends to ETF shareholders arises from several related facts. First, dividends cannot be paid or reinvested until the clearing firm knows who is entitled to receive the dividend. Second, for exchange-traded securities, the record date (when the clearing firm first knows who is entitled to receive the dividend) follows the ex date by two days. Third, clearing firms typically need at least two days following the record date to process the dividend, which could consist of paying cash or reinvesting the dividend in additional ETF shares. Taken together, these facts mean that the dividend will not be available to ETF shareholders until at least four days after ex date, regardless of whether it is paid in cash or reinvested.

In contrast to the four day delay between ex date and payment date that will be experienced by ETF shareholders, conventional shareholders will have their dividends reinvested on ex date. As a result, conventional shareholders will be continuously invested, while ETF shareholders who wish to reinvest will be “out of the market” for four days with respect to amounts distributed by the Funds.

Appendices A and B are Applications for Exemptive Relief filed by The Vanguard Group, Inc. to permit stand-alone index funds that invest in fixed income securities (e.g., bonds) to issue exchange-traded shares and to actively manage the ETF share class. Appendix A is directed toward an actively-managed TIPS fund and Appendix B is directed towards a more general Treasury index fund. In alternative embodiments, the fixed income securities may be funds that invest in corporate bonds, mortgage backed securities, international bonds, and the like.

Although the disclosed embodiments are investment companies that invest substantially all of their assets in fixed income securities, the scope of the invention includes “balanced fund” investment companies, wherein the fixed income portion of the balanced fund uses the inventive methods described above.

In the embodiment of the present invention described above, dividends are declared daily for conventional shares and monthly for the ETF share class(es). However, other differing dividend declaration schedules are within the scope of the present invention.

In the embodiment of the present described above, the investment company has an investment objective of tracking a specific benchmark index of fixed income securities. However, in an alternative embodiment, the investment objective is set by an investment advisor, such as in an actively managed investment company, as opposed to tracking a specific benchmark index.

The present invention may be implemented with any combination of hardware and software. If implemented as a computer-implemented apparatus, the present invention is implemented using means for performing all of the steps and functions described above.

The present invention can be included in an article of manufacture (e.g., one or more computer program products) having, for instance, computer useable media. The media has encoded therein, for instance, computer readable program code means for providing and facilitating the mechanisms of the present invention. The article of manufacture can be included as part of a computer system or sold separately.

It will be appreciated by those skilled in the art that changes could be made to the embodiments described above without departing from the broad inventive concept thereof. It is understood, therefore, that this invention is not limited to the particular embodiments disclosed, but it is intended to cover modifications within the spirit and scope of the present invention. 

1. In an investment company that invests at least a portion of its assets in fixed income securities and declares dividends from income earned on the assets and that has issued (i) one or more classes of shares that are bought from and redeemed with the investment company at the net asset value, and (ii) one or more classes of shares that are listed for trading on a securities exchange and that are bought and sold in the secondary market at negotiated market prices, and that includes one or more computers and one or more databases that maintain information regarding portfolio holdings of the investment company and information regarding outstanding shares issued by the investment company, wherein the outstanding shares are shares in the portfolio holdings of the investment company, the outstanding shares including the one or more classes of shares that are bought from and redeemed with the investment company at the net asset value and the one or more classes of shares that are listed for trading on a securities exchange and that are bought and sold in a secondary market at negotiated market prices, a computer-implemented method comprising: (a) the one or more computers periodically recording declared dividends for the outstanding shares issued by the investment company in the one or more databases, the one or more computers recording declared dividends in the one or more databases at a regularly scheduled first time interval for the outstanding shares issued by the investment company that are bought from and redeemed with the investment company at the net asset value and recording declared dividends in the one or more databases at a regularly scheduled second time interval that is different from the first time interval for the outstanding shares issued by the investment company that are listed for trading on a securities exchange and that are bought and sold in the secondary market at negotiated market prices; (b) the one or more computers calculating the amount of dividends to declare from the information maintained in the one or more databases; and (c) the one or more computers of the investment company paying the declared dividends of the outstanding shares issued by the investment company that are listed for trading on a securities exchange and that are bought and sold in the secondary market at negotiated market prices, and the outstanding shares issued by the investment company that are bought from and redeemed with the investment company at the net asset value.
 2. The method of claim 1 wherein the investment company invests substantially all of its assets in fixed income securities.
 3. The method of claim 1 wherein the first time interval is daily.
 4. The method of claim 1 wherein the second time interval is monthly.
 5. The method of claim 1 wherein the first time interval is daily and the second time interval is monthly.
 6. The method of claim 1 wherein an owner of any share of any share class has an undivided interest in the investment company.
 7. The method of claim 1 wherein the investment company is an open-end fund.
 8. The method of claim 1 wherein the shares that are bought and sold in the secondary market at negotiated market prices are exchange-traded shares.
 9. The method of claim 1 wherein the investment company has an investment objective of tracking performance of a specific benchmark index of fixed income securities.
 10. The method of claim 1 wherein the declared dividends of (i) the outstanding shares issued by the investment company that are listed for trading on a securities exchange and that are bought and sold in the secondary market at negotiated market prices, and (ii) the outstanding shares issued by the investment company that are bought from and redeemed with the investment company at the net asset value have a payment date, each have a respective payment date, and step (c) further comprises: the one or more computers paying the declared dividends of the outstanding shares issued by the investment company that are listed for trading on a securities exchange and that are bought and sold in the secondary market at negotiated market prices at least a predetermined number of days after the payment date of the outstanding shares issued by the investment company that are bought from and redeemed with the investment company at the net asset value. 